Should central banks hold gold home or in the US?

Chavez Gold

Since the 2008 financial crisis we hear more and more of gold repatriation by central banks. Why?

Everybody agrees that gold is money “in extremis” if not just “money”. For thousands of years it has been said to keep some (5-10%) gold and pray God you will never need it. When any other medium of exchange fails gold is still accepted. The most recent case has been the 2008 crisis. At the peak of the crisis the only accepted guaranty by central banks was gold. During the cold war both Russia and China used gold to transact with the rest of the world. During the 70s when worldwide the dollar was collapsing gold exploded. When Iraq became isolated by the US it immediately switched to gold. A few years later Libya did the same thing. Soon after restrictions were imposed on Iran gold became a major currency for Iran and suitcases of gold started to move from Turkey to Iran trough Dubai. After the conflict between Venezuela and the US escalated president Chavez repatriated gold reserves to Venezuela.

World Gold Reserves

Gold has no counterparty risk. It is recognised and accepted in time and space. But it is not enough to own gold you should also have it in your possession. Holding gold in a foreign country puts the legal right owner at risk of having his gold confiscated or blocked by the country that holds it in trust. Trust can vanish at the speed of light. We have seen how fast friends become enemies. Iran before the 1979 revolution was an allay of the US. Overnight it became an enemy and its assets frozen by the US. After the World Trade centre terrorist attack in New York, the US declared anybody who is not with “us” an enemy. All of a sudden especially France but also Germany found themselves as US enemies. Lucky for France the president of France Charles de Gaulle understood the value of gold and its possession and repatriated all the French gold in the late 60s. German gold could have been frozen to force Germany to support the US against its wishes.

Many European countries moved their gold for safety to the US during the second world war. The US was the least susceptible to be occupied by Germany. The US also had manageable debt and no deficit. The US’ reputation was at the top and trust was at its highest. It was an excellent decision for European countries to store their gold in such a country and in such extreme circumstances.

However, once the war was over there was no reason anymore to store their most precious asset in another country. The new danger coming from the Soviet Union convinced many European countries to continue storing their gold in the US. Europe was destroyed in 1945 and impossible to defend itself in any way immediately after the second war. The new treat of the Soviet Union justified both the creation of NATO military alliance and the continuation of storing gold in the US. After the reconstruction of the economy, infrastructure and military in the 1970s and the collapse of the Soviet Union in 1990s those reasons vanished. It was time to repatriate the most liquid asset home.

What happened? Why didn’t the Europeans repatriate their gold? My interpretation is that a new school of economics emerged in the US economics faculties based on debt. The successful defeat of inflation by Paul Volker boosted the US dollar and the US regained its reputation and trust. But it was only temporary. This new school of economics also created a false theory that everything has to be speculated and gambled for a profit. Gold, as it was incorrectly said, pays no interest or dividend therefore is a “worthless and useless rock” and cash was trash. Under Wall Street advise many central banks were convinced to lend their gold to “make a profit”. So gold remained mostly in the US but also in London to be used for trading, speculation and I would add gambling.

By 2000 everybody believed the US had discovered the secret to eternal prosperity and the end of business cycles. No need for such “relics of the past” as gold. It was a big mistake. Peter Bernstein wrote a book in this period about gold (The Power of Gold – History of an Obsession). He didn’t believe in the return of gold as money but having lived almost a century he cautioned that “Gold may again serve as the ultimate hedge in chaotic conditions. Its return to its traditional role as universal money is unlikely, however, unless the time should come when the dollar, the euro, and the yen have all failed to function as acceptable means of payment across international borders.” Ten years after he wrote this we had the 2008 financial crisis and a return of gold into the international monetary system. As you can see it in the chart above, it is also at that time that world central banks stopped selling gold reserves and started buying again.

At the same time trust in the US as a trustee collapsed and more and more European citizens started to request from their governments to repatriate gold reserves from the US. At first the European finance and economic establishment, mostly if not all trained or I should better say brainwashed in the 80s and 90s US economic curriculum, strongly resisted. Some in Germany even used ridiculous arguments that it is impossible to physically move gold with today’s transportation technology from New York to Frankfurt in less then 20 years. In the meantime, gold was flowing from Zurich to Shanghai and from Vietnam to Switzerland and back safely and in less than a year. However, popular pressure grew all over Europe and soon one by one central banks from Holland, Austria and Germany started to repatriate gold from the US.

This move of gold away from the US indicates to me also a growing mistrust, not just in Europe but worldwide, in the US. A very good visual description of this mistrust is the drop in earmarked (custodial) gold holdings as you can see in the two charts below. Earmarked gold is gold in trust with the Fed in New York by foreign central banks. We see that the trend started in 1970 and corresponds with the collapse of the gold exchange standard (Bretton Woods Agreement). In the second chart we can clearly see the trend accelerating downward just before the 2008 financial crisis and accelerating again since 2014.

FRB Earmarked Gold 2

FRB Earmarked Gold

I expect this trend to continue towards zero as the collapse of the present international monetary system (based on the dollar) approaches and will end with a reset. As I said there is no reason now for any country to hold gold abroad. Gold is ‘in extremis” money and should be in your possession not just in your ownership. Iran’s ownership of assets in the US were useless. The US had the possession and used it to its advantage and in its interest. Since September 11, 2001, the US has been freezing foreign assets more and more and is using its “hegemon” position to impose its will with treasury wars. The acceleration of this trend to the downside of earmarked gold holdings should be watched closely for any panic repatriation by foreign central banks. Just before the collapse of the London Gold Pool in the 60s the same thing happened. A run on the dollar by foreign central banks to exchange their dollars into gold forced the US to close the window and end the gold exchange standard.

Under “in extremis” circumstances gold ownership is not enough protection you also need possession.

Putin Gold Bar